There’s no secret formula when it comes to evaluating potential commercial real estate investment properties.
Just like investing in stocks, real estate investors, analysts and industry experts often scrutinize the key metrics of an industrial property, such as its rate of return and cash flow, before making any decisions on investment properties. Those numbers can only take you so far, though. You’ll also have to factor in how much profit your real estate investments have the potential to generate, whether it’s through long-term asset appreciation, recurring rental income, or a combination of the two.
And there’s yet another consideration when the commercial investment real estate under consideration is an industrial property. This subcategory of commercial real estate proved exceptionally resilient during the pandemic and even soared following the wide-scale ramp-up in online commerce that started when Covid-19 hit a few years ago.
It’s within that framework that we’ll take a look at how investors evaluate industrial investment properties.
Overview of Factors to Consider When Evaluating Industrial Commercial Real Estate
Investors have many things to take into account when evaluating commercial real estate, and the industrial market brings additional investment considerations. The factors that may make a multifamily apartment or retail strip center pencil out won’t directly translate to the industrial market due to what we believe will stem from robust investment demand from institutional investors and a shortage of new class A industrial space in many flourishing distribution and ecommerce markets.
Industrial investment is unique to commercial real estate. There are eight different subcategories of industrial properties:
- Light manufacturing
- Heavy manufacturing
- Flex
- Warehouse
- Data storage
- Research and development
- Showroom space
- Food processing, refrigeration and cold storage
Each of these subcategories shares some similarities, and the demand drivers for each type of product can be heavily affected by both micro and macro economic trends.
Some of the major demand drivers – whose impact varies by geographical region – include the following factors:
Age and design of the building. Aging industrial buildings lack modern design amenities such as upgraded infrastructure, technology, and size. That last is perhaps the hardest to overcome – many of today’s industrial tenants require the 36-foot clear heights common with modern Class A industrial buildings since they provide much greater racking space in the same footprint as smaller buildings. Developers have been hard-pressed to keep up with tenant demand in the sector, leading to high costs, 100-percent pre-leasing of speculative industrial buildings, and record-low industrial vacancy rates in some key distribution markets.
With institutional investor and tenant demand focused on Class A industrial properties, retail investors and other potential industrial property owners may find value-added opportunities with older and smaller Class B or C industrial properties where tenant improvements and building upgrades could attract a strong tenant base and increase the value and income-generating potential of these assets.
Location
For many industrial properties, location is the main reason why the tenant signed a lease for the building. Countless industrial properties in national or regional distribution hubs such as Chicago, Atlanta, Houston, Reno, Long Beach and New Jersey service millions of customers in nearby states with goods and products.
Some of these distribution hubs are main points of entry into the U.S., such as the Port of New York and New Jersey, while some are strategically located to serve a broad swath of the country, such as Reno – truckers can reach 11 Western states within a one-day’s drive from Reno. Prices for industrial properties of all sizes and classes in these areas often reflect the relevance and importance these regions play in the national warehouse and distribution network.
Workforce, Transportation and Other Factors
Industrial tenants often require hundreds, if not thousands, of rank-and-file employees (think Tesla’s Gigafactory), as well as many specialized managerial, executive and operational workers. Large industrial users tend to locate or expand in metropolitan areas with large workforces in an effort to reduce the risk of staffing shortages.
Industrial tenants such as online retailers or manufacturers also may require access to large transportation networks that may include interstate trucking, rail, air or port access. Smaller industrial users, meanwhile, may cater to regional markets with their products and services and aren’t so dependent on an extensive transportation network.
These are just a few of the factors that can come into play with industrial properties and affect tenant demand and asset valuation.
Capitalization rate. Cap rates are the buzzword of commercial property brokers, and for good reason. Cap rates represent the potential yield from an income-generating investment over the course of one year, assuming the asset was purchased in an all-cash deal and did not include any financing.
This number is important because investors can use it as a rough guide to estimate potential returns and make a more informed decision of whether or not the investment warrants their capital attention. Cap rates still must be supported with proper due diligence and any other market insight you can glean through personal research or expert insight.
Putting it all Together
These are some of the main factors to consider when evaluating industrial properties. Each demand driver listed above can have a micro-level effect on industrial properties, while macro-level events such as the continued migration to online retail affects the broader industrial market.
Experienced industrial brokers in your region are likely to be well aware of the trends and market drivers that affect industrial properties in your area. Leaning on their expertise is a good place to start when evaluating industrial properties.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Programs that depend on tenants for their revenue may suffer adverse consequences because of any financial difficulties, bankruptcy or insolvency of their tenants.
Certain risks are inherent to the industrial real estate industry, such as significant capital investment can be required, long-term leases are often fixed and do not allow for increase in rents or adjustments if inflation rises, industrial buildings can be at risk of becoming obsolete as technology advances, increased government regulation exposure, more sophisticated tenants with experience in lease negotiations, and properties may be built to tenant specifications and therefore more difficult to lease at end of lease term.
